Sam Mahtani is still positive about emerging markets as they continue to outperform the developed world, although this year he expects more modest returns
Emerging markets have seen two years of stellar returns where larger markets, such as India, have driven performance. There is continued reason to be positive about the asset class for 2005, although for this year more modest returns are expected.
To recap, emerging markets are the growth opportunities of the future. By definition, they are riskier than their developed counterparts, but they also offer greater potential returns. Emerging countries account for the majority of the world's population, land and natural resources. Improvements in education and infrastructure are helping countries around the world to tap into their latent potential, and many exciting investment opportunities are anticipated for the future.
Emerging markets are typically economies where GDP per capita is lower than that of the developed world. The economic growth that is occurring to bridge this gap is a key reason for emerging market investment. Emerging markets have the advantage of being able to use techniques and technology already developed by others to drive their own growth. Without the need to invent the tools from scratch, it is unsurprising that emerging markets can grow at much faster rates than developed countries were capable of at a similar income level.
By way of example, the UK, at the forefront of the industrial revolution, took 60 years to double its per capita output (via new technology and increased productivity). Starting from a similar capita income base, it then took the US 45 years to double productivity, as it was able to take advantage of tried and tested machinery and knowledge. Japan managed the process in 33 years, Brazil in 20 years, and China in only 10 years. This shows the growth rate advantage in adopting technology developed elsewhere. Estimates are that Asia will overtake developed Europe over the next few years.
The domestic growth story
Certain emerging markets are benefiting from strong, domestically-driven economic recoveries. An important shift for emerging markets has been the increasing role that the domestic story is taking in determining market performance. Emerging markets still respond with strength to events in developed countries, but somewhat less so than previously. Broadly, fiscal accounts and debt levels are much improved in comparison to several years ago, and emerging countries are beginning to reap the benefits of this. Some markets in particular stand out in this regard, including India, Malaysia, China and Thailand. India was a particularly strong domestic story in 2003, for example, as the country benefited from an exceptional monsoon season and the consumer re-entered the picture. Of course, when developed markets pick up, as we are seeing now, this serves as an added bonus to markets that are already on the upturn.
Malaysia is another strong candidate for domestic growth. The country has, for the most part, lagged since the crisis in 1997 but, given a strengthening domestic environment, is now primed for a turnaround. The government has been a big spender ever since the Asian crisis, supporting the economy. At the beginning of 2003, the government announced it would be reducing fiscal stimuli. After an initial lurch, the market has accepted this shift and the consumer appears to be picking up the slack. We view this shift from government to consumer spending as an important change and a significant positive. Recently, there has been a noteworthy pick up in domestic consumption, manifesting itself in a higher number of car loans, attractive mortgage rates and increased liquidity. The weak US dollar should also prove beneficial in an Asian context and with other Asian currencies appreciating, Malaysian goods will look increasingly attractive.
While Malaysia is poised to benefit from heightened levels of exports in combination with a stronger domestic story, there is one market that has already begun to reap the rewards of these two factors - Thailand. Thailand, as the trigger for the 1997 crisis, was severely troubled following the collapse of the baht. Since then, the country has made a dramatic turnaround and has only recently begun to see the benefits - in fact, the Thai market was up over 140% in US$ terms in 2003 alone. The devaluation of the currency has helped support an increasing level of exports. Furthermore, gearing in the country is currently quite low, inflation is under control and wages are rising in line with the economy. Earnings estimates are rising in line with the stock market, meaning that valuations are still quite attractive. Banks, property and construction companies particularly stand out as the domestic story continues to play out. Malaysia's recovery is unlikely to be as dramatic as Thailand's, but both markets should see domestic strength over the course of the coming months, although the domestic growth story in China is perhaps the one with which investors are most familiar.
On this basis, managers are looking to capitalise on the countries with the strongest domestic fundamentals in 2005. As such, the main portfolio theme at the moment is a focus on plays that are not dependent on a strong US economy. India and Thailand are among favoured areas with GDP growth of around 6% predicted for both countries. What is more, inflation is likely to be a regional driver in Asia throughout the course of the year, wages are also rising and consumption continues to be a force. In this regard, interest rates are likely to continue moving upwards in China. Nevertheless, soft commodities and agriculture should do well in China, and managers are looking at the best way to play this trend - via transport companies, soft commodities, or more directly. In general, however, macro data comparisons will not be particularly favourable in Asia over the course of the year as high base data will make comparisons difficult. Most managers remain bullish on the domestic story in Taiwan, while none of the smaller Asian markets really stand out as particularly exciting with the exception of Thailand.
Greater attention to shareholder value
Emerging markets are likely to exhibit much stronger growth than OECD economies over the next decade. Over the period 1965-2000 emerging markets demonstrated annual GDP growth of 5.9% (versus 3.6% for OECD). The period of lower growth in the 1995-2000 period was seen as a temporary aberration due to the inappropriate currency pegs and their subsequent collapse. Over the next decade it is expected these higher rates of growth to continue. There have also been indications that the drop off in FDI witnessed in the uncertainty of 2002 is reversing and volatility and risk aversion indices are near their lows as investor confidence returns to the market.
Emerging market governments are also becoming increasingly open - trade barriers are slowly being eliminated and capital controls are being loosened. Companies are following suit and corporate governance is improving, as well as attention to shareholder value. Given all these developments, the inherent prospect for higher growth in emerging countries, attractive valuations and an improving global outlook, there is reason to remain confident in our assessment that emerging markets will continue to outperform the developed world for at least the next two to three years, although more modest returns in 2005 are expected.
Emerging countries account for the majority of the world's population, land and natural resources.
Emerging markets have the advantage of being able to use techniques and technology already developed by others to drive their own growth.
Emerging markets will continue to outperform the developed world for at least the next two to three years.
Putting the tech into protection
Square Mile’s series of informal interviews
Fallout from Haywood suspension
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